Understanding Your Practice Balance Sheet
Wednesday, June 19, 2019 9:00 AM
For medical practice leaders and physician owners, monitoring and maintaining the financial health of their practice is one of the most important parts of their job. To carry out this responsibility, these individuals need a comprehensive understanding of key financial statements such as the income (or profit and loss) statement and the balance sheet. While the income statement is generally easy to interpret, the balance sheet is oftentimes more complicated. However, breaking down the balance sheet into its individual parts makes it easier to understand and allows leaders to use it as a tool by which they can gauge the financial health of the business.
One of the most effective ways to better understand the balance sheet — or any financial-related topic, for that matter — is to look at it from a personal perspective. When you do this, the concepts and terminologies used become more relatable, making it easier to recognize how they translate to reviewing business-related financial documents. To better understand the correlation, let’s look at how the practice balance sheet is set up, followed by what it means from a personal financial perspective.
Balance Sheet Equation
Put simply, the balance sheet tells us what a company owns (its assets) must equal what it owes, either to creditors (liabilities) or shareholders (equity). While the profit and loss statement is a summary of results over a period of time — such as a month or year — the balance sheet provides a snapshot of financial position as of a specified date in time (e.g., as of 12/31/18 or today’s date). The balance sheet is normally expressed in the following equation:
From a personal perspective, creating your own balance sheet is often referred to as a statement of net worth, where what one owns (assets) less what one owes (liabilities) equals one’s net worth (or equity). When we break down our own personal financial situation to these individual parts, it becomes much easier to make educated decisions and plan for the future.
To better understand what makes up your personal balance sheet, let’s divide it into three main components. My hope is that by understanding the makeup of your personal balance sheet, interpreting the balance sheet of the practice (or any business) will become less daunting.
1. Assets. Assets can typically be broken out into three sub-categories: current assets, personal property, and other assets such as investments.
- Current Assets: Often referred to as liquid assets, this denotes items like cash or the balance of checking or savings accounts, which can be quickly accessed to pay for expenses or other obligations.
- Personal Property: These are valuable assets one owns, yet they can only be turned into cash if sold (after debt obligations are met). Examples include a house or car (if owned), furniture, artwork, or other large/valuable items.
- Other Assets: This sub-category includes investments such as a stock portfolio, mutual funds, retirement accounts, etc.
2. Liabilities. Liabilities represent amounts that are owed and have not yet been paid; these can be broken out into two sub-categories: current liabilities and long-term liabilities.
- Current Liabilities: Current liabilities represent what is owed, typically within the next 12 months. Examples include outstanding bills, auto and mortgage payments, and other loans (i.e., student debt).
- Long-term Liabilities: Long-term liabilities represent the remaining principle and interest on outstanding loans, less what is owed in the current period (i.e., a mortgage or auto loan).
3. Equity (or Net Worth). Once liabilities are subtracted from assets, the resulting amount is your equity. It represents what is left over after all debt obligations are met. The amount ideally is a positive number, as a negative result indicates that you owe more than you own.
Using the Balance Sheet as a Planning Tool
Defining and completing each component of a personal balance sheet makes understanding one’s current financial position — and more importantly, planning for the future — an easier process. Doing this allows us to know what variables will improve our situation, be it increasing the value of our assets or decreasing our liabilities. This knowledge allows individuals to make informed decisions and ensure they are prepared for the future. With that said, the balance sheet for a practice should serve the exact same purpose.